Get Ready For The Run To All-Time Highs

The market suffered a sharp correction that began last week that shocked the markets by falling a whopping 2.81%. Of course, since the market has suffered that big of a drop since late last year it was understandable that investors panicked a bit. However, as we stated during our nightly radio broadcast:

"The market has done nothing at the moment to violate any of the bullish technical trends that are currently entrenched in the market. Nor has the current correction done much to alleviate the overbought, over extended and overly bullish state that we addressed in this past weekend's missive. At the current time there is no need to reduce the equity exposure in our current model. However, the recent push higher in interest rates has made bonds much more attractive price wise."

The chart below shows the S&P 500 since the turn of the century and shows the clearly defined bullish uptrend in the market as well as rising peaks after each major correction.

Besides the technical conditions that currently exist - the primary reason we did not reduce equity risk in our portfolio models, which are currently fully allocated, is due to the continued liquidity push of the Fed's dual quantitative easing programs. The testimony on Tuesday confirmed our views when Bernanke stated:

Moreover, although accommodative monetary policies may increase certain types of risk-taking. in the present circumstances they also serve in some ways to reduce risk in the system. most importantly by strengthening the overall economy. but also by encouraging firms to rely more on longer-term funding. and by reducing debt service costs for households and businesses. In any case, the Federal Reserve is responding actively to financial stability concerns through substantially expanded monitoring of emerging risks in the financial system, an approach to the supervision of financial firms that takes a more systemic perspective, and the ongoing implementation of reforms to make the financial system more transparent and resilient. Although a long period of low rates could encourage excessive risk-taking, and continued close attention to such developments is certainly warranted. to this point we do not see the potential costs of the increased risk-taking in some financial markets as outweighing the benefits of promoting a stronger economic recovery and more-rapid job creation.

Translated, this simply means that Bernanke is going to continue the current liquidity programs for as long as necessary to achieve his end goals regardless of the creation of another asset bubble. The problem, as has always been the case and as shown in the chart below, is that the Bernanke states that he has the foresight and monetary tools necessary to withdraw liquidity from the system before the next crisis occurs. Unfortunately, there is no historical evidence to support this claim.

While the correction that occurred in the markets over previous few days was enough to provide room for a run at new market highs it did little to reduce the overly bullish and overbought conditions in the market. At this point, with investors beginning to show some signs of panic they have "missed the boat," the probability that the market achieves a new high is extremely likely.

At this time we are still confident in our price target of 1560 on the S&P 500 this year. However, it is possible that the markets could rise to the rising trend line, as shown in the first chart above, of 1600. However, let me be clear - while our target is 1560 I am not saying that is where the year will end. At the current trajectory that target could be reached as early as this summer. However, as David Rosenberg correctly stated in his recent missive:

One thing to keep in mind that could well limit the severity of any near-term correction is the Fed. Recall that in 2010, and again in 2011, the Fed was scheduled to terminate its Quantitative Easing programs and this aggravated the selloff. So after crying 'uncle' twice to stem the market's decline and extending QE, the Fed late last year, introduced perpetual QE — and Bernanke yesterday gave no sign at all that he is about to back away from the program. He doesn't see bubbles forming: and if he did, he made it quite clear that the dual mandate of full employment (not there with a U6 rate over 14%) and price stability (in the current case, preventing deflation) would still take precedence. I have long cited the 85% correlation between the Fed's balance sheet and the market's direction over the past four years — the extent to which the laws of diminishing returns begin to set in will be interesting to see, me-thinks, over the next several weeks and months.

As we have been pointing out in recent missives - the underlying economics and fundamentals are not supportive of expanding valuations based on price increases alone.

The weekly chart of the S&P 500 index above shows the markets still in extreme overbought territory and at levels that have normally been associated with intermediate term tops. This overbought condition combined with excessive investor optimism supplies the ingredients necessary for another correction of 10% to 20% as seen over the past three years. However, as Rosenberg stated, with a never ending QE program in place the catalyst for such a correction will likely be something far more serious than the current budget debates in Washington.

My best guess, as I have been discussing for the past four months, is that by the end of the summer the Eurocrisis will be back. The recent elections in Italy, and the subsequent curtailment of austerity, clashes with the goals and plans set forth by the ECB last year. Furthermore, the German elections may also prove disastrous to the ECB plan if Angela Merkel is unseated.

"Now it is up to those who were elected in Italy on Sunday to form a stable government. The faster they do this, the quicker the uncertainty will be overcome, and by the way, I never said the euro crisis was over. I only said that we have made significant progress. We need to continue on this path, but we will have setbacks."

His statement was also confirmed previously by Angela Merkel's economic advisor who stated in an interview that:

"The sustainability of Italian public finances is in jeopardy. The euro crisis will therefore return shortly with a vengeance." Apparently, the Italians were not ready to move on the path of reform that has been taken by Mr. Mario Monti, Field said. "You cannot expect that Italy's European partners or the ECB will stabilize the Italian economy, when its people are not ready for reform."

Running For The High

While I currently am maintaining our price target of 1560 currently that is simply a function of the current technical trends. That bullish trend is supported, at the moment, by excessive bullish optimism and $85 billion a month in liquidity. Market participants, like a marathon runner, are so amped up on endorphins that they lose awareness of their surroundings. Right now, investors see the finish line just ahead as CNBC flashes banners on their screen with countdowns of points to reach a new all-time high.

However, it is important as investors, that we do not simply dismiss the dangers that continue to build in the economy and the markets. To simply assume that there are no excesses being created in various asset classes is short sighted. Asset "bubbles" are never recognized, or acknowledged, until after the fact. Currently the increases being witnessed are primarily due to the inflows of liquidity which is masking the deterioration of fundamental underpinnings. That is an unsustainable trend in the longer term, but, in the short term there is nothing inhibiting further increases as long as complacency remains high.

At some point, and it is only a function of time, reality and fantasy will collide. When this occurs the media will question how such a thing could of happened? Questions will be asked why no one saw it coming. Fingers will be pointed and blame will be laid. This will happen. When? Later this year? Next year? Timing is always the problem. This is why it is more important than ever that you remain aware of the risks and pay attention to exposure that you take on within your portfolio. There is no prize for beating the market from one year to the next, however, there are severe penalties when things don't go as planned.

Lance Roberts is the General Partner and Chief Portfolio Strategist for STA Wealth Management. He is also the host of "Street Talk with Lance Roberts", Chief Editor of "The X-Factor" Investment Newsletter and the Streettalklive daily blog. Follow Lance on Facebook, Twitter and Linked-In